Russia announced a ban on food imports from the European Union, the US and other countries in retaliation to the sanctions imposed on it earlier. The tension around the Ukraine crisis may have already taken its toll on the euro-zone, but now it could significantly worsen.
A ban on food exports to Russia means an excessive supply stuck in Europe and this could put price pressure. Headline inflation is already at a 5 year low of 0.4% and this could further tip it lower. No, Russia is not the only country the euro-zone exports to, but a small change in supply could serve as the tipping point to change the balance.
Already very weak growth
The recovery in the 18 country monetary union is quite minimal and we have already seen signs of a slowdown: German industrial production and factory orders have both been very disappointing and point to a significant slowdown of German growth in Q2, which stood on 0.8% in Q1. Despite the strong German growth, EZ growth stood on only 0.2%.
Italy, the zone’s third largest economy, surprisingly fell into recession after its economy squeezed in Q2, following a shrink in Q1. France isn’t doing too well: unemployment is on the rise and consumer spending does not show positive signs. From the four big countries, only Spain enjoys stronger growth. However, inflation has already become negative in Spain. It’s outright deflation with a y/y drop of 0.3%.
This strong retaliation by Russian may not only weigh on euro-zone exports, but push the zone closer to the dreaded deflation. In order for the euro-zone not to “turn Japanese”, perhaps quicker action is needed from the European Central Bank.
Steps already taken – are they enough?
The ECB did introduce a negative deposit rate and more measures, and we are seeing some green shoots in more willingness of banks to lend, at least in Spain. However, the exchange rate is certainly not supportive of a pick up in inflation.
An outright large scale Quantitative Easing program in which the Frankfurt based institute floods the continent with euros would devalue the common currency, push inflation higher and allow more competitiveness for European exports, even with less access to the large Russian market.
Will Draghi bite this additional bullet coming from Moscow and ask for patience until the measures gain a stronger hold?
Or will this Russian move, together with the worries about banks as seen in the BES case in Portugal force more action?
What do you think?
Here is our podcast which discusses the ECB options:Get the 5 most predictable currency pairs